One of the big advantages of owning a home is that one day you’ll have paid for it outright. You’ll have no housing costs, no debt, full security of tenure; a few less things to worry about in old age.
But what if all that time you weren’t actually paying off your mortgage – you were just paying the interest on the debt? There are 2.6 million people in Britain with interest only mortgages, and comprehensive new research by the Financial Conduct Authority (successor to the Financial Services Authority) suggests that many of these people are ill-prepared for the end of their mortgage term.
Why would you take out a mortgage that wasn’t paying itself off? In the 80s and 90s, some mortgages were sold with ‘endowment’ policies, whereby the capital value of the home was invested in stocks and shares with the hope that the returns would do the trick. Many didn’t.
But in the 2003-8 credit boom interest only mortgages were being sold without any obligation to find a way of repaying them. As house prices soared in that time, the only way that many could afford their home was to pay only the interest on the mortgage (and ‘afford’ in the loosest sense, with people being lent as much as seven times their income).
Historically low interest rates have helped keep this problem dormant, but the graph below from the FCA’s analysis suggests it will blow up in the coming decades, as more of the mortgages leant in 2003-8 come to the end of their term.
The interest only ‘timebomb’ is that many of the people with these mortgages will come to the end of their term and they won’t own their home. If their house price hasn’t risen since they took out the mortgage, they will have no money in their home. They will find that they have effectively been renting a home for that time.
For those who bought in the 80s and 90s, exponential house price growth will cushion the blow. Even so, most will have a shortfall between what they have in their home and what it’s worth. They will likely have to sell the home they’ve lived in all that time, but may find what’s leftover isn’t enough to buy much at all.
The graph below shows that people’s likely (modelled) shortfall is worse than they are predicting (reported). And that the shortfalls will be particularly severe for people who took out interest only mortgages at the height of the lending boom. The most severely affected 250,000 will have an average shortfall of £131,000.
The scale of it is alarming. A substantial proportion of our ‘nation of homeowners’ will see their dream burst at some point in the not too distant future. Meanwhile, the high house prices that lead people to take out interest-only mortgages continue to lock out the next generation.
What’s clear to me is that we need policy solutions to address this situation. Conventional home ownership isn’t working for them. Help to Buy’s 95% mortgages won’t make their situation any more sustainable.
We need to help manage people out of unsustainable homeownership before it’s too late and we have an ugly repossessions crisis on our hands. My punt is that we need to expand intermediate housing options (in new supply) that are affordable for middle income households like these and others in the long term.